In a move that surprised many observers for its aggressiveness, the Federal Reserve Board on Tuesday, Dec. 16th, lowered the federal funds rate, the interest rate at which banks lend to one another, from 1% to a range of 0 to .25%. Many observers had expected a .50% cut, not the .75 to 1.0% cut that the Fed has effected. The lowering of the interest rate points to a Fed extremely worried about the health of the economy going forward.
The Fed also announced other efforts to fight the specter of deflation, using, as it says, “all available tools to promote the resumption of sustainable economic growth and to preserve price stability.” These tools include supporting
the functioning of financial markets and stimulat[ing] the economy through open market operations and other measures that sustain the size of the Federal Reserve’s balance sheet at a high level. As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.
Federal Reserve Building
Together with the interest rate cut, these policies give insight on just how concerned federal officials are about the state of the economy. With job losses increasing, credit still tight, and prices deflating, the Fed wants to pump a flood of liquidity into the system to prevent a disastrous deflationary spiral.
The incoming Obama administration is also promoting an immense stimulus package that will pump even more money into an economy that it and the Fed are trying to reflate. Congress’s cooperation, with Democratic majorities, seems assured, although the defeat in the Senate of the auto bailout bill may portend a willingness on the part of Republicans to be obstructionist if they see political advantage.
The trouble is that if these efforts don’t work, what other ammunition do the Fed, Congress, and President-elect Obama have left? If the auto companies fail, what will the resulting shock do to the crisis of confidence the economy is in? TARP money for the automakers has yet to be forthcoming (as of this writing), and people generally seem so sour on the automakers, not without reason, that President Bush and Henry Paulson seem reluctant to drink from this cup.
I suppose one could point to the equities market and see a glimmer of hope, but that’s, at this stage, fool’s gold. With the recent volatility of those markets, how can anyone rely upon them?
And even if the Fed and Congress through monetary and fiscal policies manage to reflate the economy, what then? With the world awash in liquidity, a new specter looms: inflation and its attendant risk, hyperinflation.
By the way, lest you think I’m all gloom and doom, Merry Christmas. Look out for the New Year.
Image courtesy of wwarby’s photostream at Flickr and used under license of Creative Commons.
